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What is the monetary standard, or, how did the Volcker-Greenspan FOMCs tame inflation?

  • Robert L. Hetzel
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    A consensus now exists that central banks, which possess a monopoly over the creation of fiat money (the monetary base), control trend inflation. But how do they exercise this control, especially given that their use of the interest rate as the policy instrument renders money endogenous (determined by market forces)? This paper considers two alternatives. First, central banks control inflation through the way that they manipulate the unemployment rate (subject to a trade-off between changes in inflation and the amount of excess unemployment as summarized in a Phillips curve). Second, and alternatively, central banks control inflation by following consistent procedures that combine two characteristics. Through their consistency, these procedures provide for a nominal anchor by causing the public to expect low trend inflation that is stable in the sense of being unaffected by inflation and recession shocks. Also, they allow the price system to work in the sense of allowing market forces to determine real variables such as the unemployment rate.

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    File URL: http://www.richmondfed.org/publications/research/economic_quarterly/2008/spring/pdf/hetzel.pdf
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    Article provided by Federal Reserve Bank of Richmond in its journal Economic Quarterly.

    Volume (Year): (2008)
    Issue (Month): Spr ()
    Pages: 147-171

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    Handle: RePEc:fip:fedreq:y:2008:i:spr:p:147-171:n:v.94no.2
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    1. Marvin Goodfriend, 2004. "Monetary policy in the new neoclassical synthesis : a primer," Economic Quarterly, Federal Reserve Bank of Richmond, issue Sum, pages 21-45.
    2. Robert J. Barro & David B. Gordon, 1981. "A Positive Theory of Monetary Policy in a Natural-Rate Model," NBER Working Papers 0807, National Bureau of Economic Research, Inc.
    3. Hetzel, Robert L & Mehra, Yash P, 1989. "The Behavior of Money Demand in the 1980s," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 21(4), pages 455-63, November.
    4. Marvin Goodfriend, 2007. "How the World Achieved Consensus on Monetary Policy," Journal of Economic Perspectives, American Economic Association, vol. 21(4), pages 47-68, Fall.
    5. Nelson, Edward, 2001. "What Does the UK's Monetary Policy and Inflation Experience Tell Us About the Transmission Mechanism?," CEPR Discussion Papers 3047, C.E.P.R. Discussion Papers.
    6. Lucas, Robert E, Jr, 1996. "Nobel Lecture: Monetary Neutrality," Journal of Political Economy, University of Chicago Press, vol. 104(4), pages 661-82, August.
    7. Robert L. Hetzel, 1987. "Henry Thornton: seminal monetary theorist and father of the modern central bank," Economic Review, Federal Reserve Bank of Richmond, issue Jul, pages 3-16.
    8. McCallum, Bennett T., 1986. "Some issues concerning interest rate pegging, price level determinacy, and the real bills doctrine," Journal of Monetary Economics, Elsevier, vol. 17(1), pages 135-160, January.
    9. Marvin Goodfriend & Robert G. King, 2005. "The Incredible Volcker Disinflation," Boston University - Department of Economics - Macroeconomics Working Papers Series WP2005-007, Boston University - Department of Economics.
    10. Thomas M. Humphrey, 1983. "Can the central bank peg real interest rates? : a survey of classical and neoclassical opinion," Economic Review, Federal Reserve Bank of Richmond, issue Sep, pages 12-21.
    11. Robert L. Hetzel, 2006. "Making the systematic part of monetary policy transparent," Economic Quarterly, Federal Reserve Bank of Richmond, issue Sum, pages 255-290.
    12. Thomas M. Humphrey, 1990. "Fisherian and Wicksellian price-stabilization models in the history of monetary thought," Economic Review, Federal Reserve Bank of Richmond, issue May, pages 3-12.
    13. Goodfriend, Marvin, 2000. "Overcoming the Zero Bound on Interest Rate Policy," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 32(4), pages 1007-35, November.
    14. Orphanides, Athanasios, 2003. "The quest for prosperity without inflation," Journal of Monetary Economics, Elsevier, vol. 50(3), pages 633-663, April.
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    16. Sargent, Thomas J & Wallace, Neil, 1975. ""Rational" Expectations, the Optimal Monetary Instrument, and the Optimal Money Supply Rule," Journal of Political Economy, University of Chicago Press, vol. 83(2), pages 241-54, April.
    17. Robert L. Hetzel, 1999. "Japanese monetary policy: a quantity theory perspective," Economic Quarterly, Federal Reserve Bank of Richmond, issue Win, pages 1-26.
    18. Nelson Edward, 2005. "The Great Inflation of the Seventies: What Really Happened?," The B.E. Journal of Macroeconomics, De Gruyter, vol. 5(1), pages 1-50, July.
    19. repec:cup:cbooks:9780521881326 is not listed on IDEAS
    20. Robert L. Hetzel, 2004. "How do central banks control inflation?," Economic Quarterly, Federal Reserve Bank of Richmond, issue Sum, pages 46-63.
    21. Athanasios Orphanides, 2002. "Monetary policy rules and the Great Inflation," Finance and Economics Discussion Series 2002-8, Board of Governors of the Federal Reserve System (U.S.).
    22. Kydland, Finn E & Prescott, Edward C, 1977. "Rules Rather Than Discretion: The Inconsistency of Optimal Plans," Journal of Political Economy, University of Chicago Press, vol. 85(3), pages 473-91, June.
    23. Thomas M. Humphrey, 1974. "The quantity theory of money : its historical evolution and role in policy debates," Economic Review, Federal Reserve Bank of Richmond, issue May, pages 2-19.
    24. Robert L. Hetzel, 1998. "Arthur Burns and inflation," Economic Quarterly, Federal Reserve Bank of Richmond, issue Win, pages 21-44.
    25. Georg Rich, 1987. "Swiss and United States monetary policy: has monetarism failed?," Economic Review, Federal Reserve Bank of Richmond, issue May, pages 3-16.
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